Category: Foreign Exchange Market

Functions of Foreign Exchange Market

Foreign Exchange is the process of conversion of one currency into another currency. For a country its currency becomes legal tender. For a foreign country it becomes the value as a commodity. Since the commodity has a value its relation with the other currency determines the exchange value of one currency with the other.

For example, the US dollar in USA is the currency in USA but for India it is just like a commodity, which has a value which varies according to demand and supply. Foreign exchange is that section of economic activity which deals with the methods in which rights to wealth expressed in terms of the currency of one country are converted into rights to wealth in terms of the current of another country. It involves the investigation of the method, which exchanges the currency of one country for that of another.

Foreign exchange can also be defined as the means of payment in which currencies are converted into each other and by which international transfers are also made. Most countries of the world have their own currencies The US has its dollar, France its franc, Brazil its cruziero; and India has its rupee. Trade between the countries involves the exchange of different currencies. The foreign exchange market is where currencies are bought & sold against each other. It is the largest market in the world transactions conducted in foreign exchange markets determine the rates at which currencies are exchanged for one another, which in turn determine the cost of purchasing foreign goods & financial assets. The most recent, bank of international settlement survey stated that over $900 billion were traded worldwide each day. During peak volume period, the figure can reach upward of US $2 trillion per day. The corresponding to 160 times the daily volume of NYSE.

Globally foreign exchange market started in a major way after the breakdown of the Bretton Woods system in 1971, which also marked the beginning of floating exchange rate regimes in several countries. After 1990s witnessed a perceptible policy shift in many emerging markets towards reorientation of their financial markets in terms of new products and instruments.

The changing forms were reflected in a rapid expansion of foreign exchange market in terms of transaction volumes drop in transaction costs and efficient mechanisms of risk transfer.

The beginning of the foreign exchange market in India started in year 1978 when banks in India were allowed to undertake intra-day trade in foreign exchange. But it was in the 1990s that the Indian foreign exchange market viewed changes with the shifts in the currency regime in India. The exchange rate of the rupee that was “pegged” earlier was changed to “float “partially in March 1992 and entirely in March. The combination of the exchange rate was helpful in developing a market determined exchange rate of the rupee and an important step in the progress towards current account convertibility, which was accomplished.

In August 1994 further development of the foreign exchange market in India was provided with the setting up of an Expert Group on Foreign Exchange Markets in India which submitted its report in June 1995. The Group made several recommendations for deepening and widening of the Indian foreign exchange market.

Hence from beginning from January 1996, wide-ranging reforms have been undertaken in the Indian foreign exchange market. After a decade, an Internal Technical Group on the Foreign Exchange Market (2005) was constituted to undertake a complete review of the measures initiated by the Reserve Bank and identify areas for further liberalization or relaxation of restrictions in a medium-term framework.

The Marshall Islands Launches Its Own National Cryptocurrency

The small nation of about 53,000 people is located in the middle of the Pacific Ocean is quietly working on a project that could have a major impact on how cryptocurrency is treated by both investors and government actors.

The Marshall Island is launching its own national cryptocurrency token named the Sovereign, or SOV, which will be legal tender for citizens and businesses on the island and worldwide. This plan was created by Israeli fintech company Neema. It is the idea of CEO Barak Ben-Ezer who looked for countries that do not have their own currency to implement it. The Marshall Islands, despite being a republic since 1982, uses the US dollar as its medium of exchange and tax payment method.

Ben-Ezer said that when Neema showcased the idea, he received a few skeptic comments and mixed thoughts from the officials in government. On the other hand, the President Hilda Heine Ministry of Finance showed a positive interest in the matter. Luckily the president became infatuated with the idea and its promise, Said Ben-Ezer She immediately understood that there’s big potential here for the country and they were basically lobbying for that and convincing the other ministers until most of them were onboard. It seems now that anything is on track, but how will things go on from now?

The SOV currency will be pegged and compared to USD, as demonstrated by David Paul, the VP of the Marshall Islands. As far as things go for fiat money, The government has no will of replacing it for now. One thing’s for sure – The first period of SOV is the period that will decide its fate. If it’s going to be popular among people and business, it seems things will go great. The most important initial event will be the coin offering – Which will allow people to buy the cryptocurrency in exchange for another currency. Ben-Ezer assumes that each token will be sold for around 100$.The hard cap will be placed at 24,000,000 tokens, and is supposed to start by the third quarter of 2018, as according to Minister Paul SOV is backed by the government, what provides some stability for users and will be treated just like regular money. In late February, the government the island has no central bank authority passed the Declaration and Issuance of the Sovereign Currency Act to make all of this possible. For a cryptocurrency, it’s quite a meaningful step but on paper it still appears to be a bizarre proposition. Cryptocurrency’s original selling points were based on zero government influence and no central authority. The idea of a cryptocurrency issued by a state contradicts that.

It’s important to emphasise that this cryptocurrency, the Sovereign, is completely decentralized and the government cannot control the money supply. After the [crowd sale], they don’t have any control over the currency, it circulates, and the money supply is predetermined on the blockchain, explained Ben-Ezer. That was agreed together and it’s kind of going back to the days of the gold standard, Ben-Ezer continued. If you go back in time it used to be that when governments wanted to issue more money, they had to bring aboard more gold. They couldn’t just start the printers. According to Ben-Ezer, the SOV project gained interest among a few big financial institutions and investment firms – But he declined to say who they were.

The sov is said to launch on the Ethereum network build with the erc20 standard, that alone could get it a lot of attention from the crypto community as it could be a game changer for it being a bridge between FIAT and crypto.

The Marshall Islands isn’t the first country to attempt this. For example, Venezuela has created its own cryptocurrency called Petro, which is pegged to the price of oil and backed by the country’s oil reserves to generate funds and evade US sanctions. Other countries like Russia and Iran have played with the idea of a government-controlled cryptocurrency too. On the smaller scale, rap singer Akon plans to build a new city in senegal to use it’s very own cryptocurrency called Akoin, few details are known about the project so far, as the rapper leaves technical issues to the geeks.

President of the Marshall Islands Hilda Heine, and Minister of Assistance to the President of the Marshall Islands David Paul, while there is understandable concern by policy makers and regulators worldwide of the misuse of cryptocurrencies for tax evasion, money laundering, and terrorist financing, the SOV is designed on purpose to be unusable for these purposes, countered Minister Paul.

A KYC process will be mandatory to be able to take part in the SOV IMO (initial money offering), after the IMO, people will be able to buy in on regular exchanges, as well as in official banks worldwide. They issue to you an identity token, so each SOV wallet is associated with an identity token. You cannot send money out of an SOV wallet unless you have this identity token, said Ben-Ezer. In this manner, the funds within SOV always move between identified and verified wallets. As far as Kossow, one of key phases will be the verification process that aims to prevent cases of money laundering – A failure of that magnitude may cause investors to lose faith at the project.

Law enforcement will be able to request, with appropriate authorisation, access to the source of funds that a person has received. This information will be recorded in the blockchain, and is unalterable, added Minister Paul on the steps the government is taking to thwart illegal activity with the SOV. The fact that we have a country that took a decision to use a cryptocurrency as its legel tender can create a chain reaction, whereas the regulations and opinions about crypto may get a whole different approach. So now the SEC cannot really say it is a security and the CFTC cannot say it is a commodity and the IRS cannot say it is property, said Ben-Ezer, referring to the various regulator definitions of cryptocurrency in the US. It’s money, it’s just like the Shekel, the Euro, the Yen.

Ben-Ezer believes that the Sovereign and the Marshall Islands start the revolution and inspire other countries to follow their footsteps. Sovereign will be a portal between those two worlds by virtue of being a fiat currency and a cryptocurrency. Ben-Ezer adds. Our idea here is to create a Panama Canal between the world of fiat currencies, banks, and Wall Street and cryptocurrencies.

How Exchange Rate Changes Impact Indian Manufacturing Firms

For policymakers trying to assess the impact of exchange rate movements on the real economy, these results provide various important insights. Firstly, the short-run impact of a real depreciation on firm’s output growth is likely to be negative since it is the import cost channel that dominates in the short run. Further, the impact is asymmetric, with real depreciation having a stronger impact as compared to real appreciation.

At the same time, maintaining a competitive real exchange rate is imperative for boosting Intermediate and long-term economic growth and maintaining the external balance. Thus, using scarce foreign exchange reserves to prevent currency depreciation in the face of sustained downward pressure on the currency due to growing fiscal deficit and/ or massive capital outflows would be problematic, apart from being unsustainable. On the whole, for countries relying on volatile foreign capital inflows to finance their consumption and investment needs, a careful reserve management policy along with a sound fiscal policy are necessary to balance the multiple objectives of stable growth and external sector balance in the long run.

Inflation rates in India have risen about 8.50% amid concerns surrounding the devaluation of the rupee and the erosion of the purchasing power of savings. In spite of Governmental interventions, the rupee is in a free-fall, having slipped by over 20%, making it one of the most awful performing currencies globally. RBI made thirteen rate increases attempts to docile the inflation in last one year but hardly achieved any significant result. Inflation rate maintained upwards trend. This is now reflected through the currency depreciation. Inflation directly enhances prices and thereby affects the purchasing power of currency. Currency value and inflation have a direct co- relation and impact each other. The currency re-evaluation is also essential with the change in domestic prices affected by inflationary forces. Currency is considered to be overvalued if the suitable adjustment is not made with the price index fluctuations.

India currency devaluation has also resulted in surge of import by over 200% of gold and silver. Statistics show that imports of gold and silver to India were $8.96 billion a growth of 222%. The Reserve Bank of India purchased 200 tons of gold from the International Monetary Fund in 2009. From the start of 2011, some 30 banks in India have been granted permission to import gold and silver. Further gold purchases are expected in coming months, as the Reserve Bank has issued licenses to seven more banks to import gold and silver. Indian banks are therefore contributing to the massive increase in demand for gold and silver. Chinese banks are also catering to the increased demand of Chinese people for gold bullion for investment and savings purposes.

In fact, most of the world’s central banks are now diversifying from major currencies such as the dollar and euro into gold. In addition to India and China, these countries include Russia, Sri Lanka, Bangladesh, Mauritius, Mexico, Iran and Saudi Arabia. Financial experts believe the increased demand for gold and silver from India and wider Asia is sustainable and that it will keep the precious metal market thriving. For policymakers trying to assess the impact of exchange rate movements on the real economy, these results provide various important insights. Firstly, the short-run impact of a real depreciation on firm’s output growth is likely to be negative since it is the import cost channel that dominates in the short run. Further, the impact is asymmetric, with real depreciation having a stronger impact as compared to real appreciation.

Essay on Forex Market: Definition of Foreign Exchange Market

During -17 the common monthly turnover in the Indian overseas exchange market touched about 175 billion US dollars. Compare this with the monthly buying and selling extent of about 120 billion US dollars for all cash, derivatives, and debt devices put collectively in the country, and the sheer size of the foreign exchange market will become evident. Since then, the foreign change market recreation has extra than doubled with the common monthly turnover reaching 359 billion USD in -2017, over ten instances of the everyday turnover of the Bombay Stock Exchange.

As in the relaxation of the world, in India too, overseas change constitutes the greatest economic market by far. Liberalization has radically modified India`s overseas alternate sector. Indeed the liberalization manner itself was sparked through an extreme Balance of Payments and an overseas exchange crisis. Since 1991, the rigid, four-decade-old, fixed exchange rate system replete with severe import and overseas alternate controls and a thriving black market is being changed with a much less regulated, market-driven arrangement. While the rupee is still a long way from being fully floating (many studies indicate that the wonderful pegging is no less marked after the reforms than before), the nature of the intervention and the variety of independence tolerated have each undergone substantial changes.

With an overabundance of foreign alternate reserves, imports are no longer viewed with worry and skepticism. The Reserve Bank of India and its allies now intervene every now and then in the foreign alternate markets not to continue to help the rupee but frequently to avoid an * College of Management, Georgia Tech, 800 West Peachtree Street, Atlanta, GA 30332, USA. Email: rajesh.chakrabarti@mgt.gatech.edu. two appreciation in its value. The full convertibility of the rupee is clearly seen on the horizon. The results of these developments are palpable in the explosive increase in the foreign exchange market in India. Foreign Exchange Markets in India a brief heritage The overseas exchange market in India commenced in earnest less than three decades ago when in 1978 the authorities allowed banks to alternate overseas alternate with one another. Today over 70% of the trading in overseas exchange continues to take place in the inter-bank market.

The market consists of over 90 Authorized Dealers (mostly banks) who transact foreign money amongst themselves and come out square or except publicity at the quiet of the buying and selling day. Trading is regulated by the Foreign Exchange Dealers Association of India (FEDAI), a self-regulatory affiliation of dealers. Since 2001, clearing and contract features in the foreign change market are generally carried out by way of the Clearing Corporation of India Limited (CCIL) which handles transactions of about 3.5 billion US bucks a day, about 80% of the complete transactions.

The liberalization technique has appreciably boosted the overseas alternate market in the u. s. a . by means of allowing both banks and corporations increased flexibility in protecting and trading overseas currencies. The Sodhani Committee set up in 1994 advocated increased freedom for collaborating banks, allowing them to fix their own trading limits, interest fees on FCNR deposits, and the use of by-product products. The growth of the foreign exchange market in the final few years has been nothing much less than momentous.

In the ultimate 5 years, from 2011-12 to -17, buying and selling extent in the foreign exchange market (including swaps, forwards, and forward cancellations) has more three than tripled, growing at a compounded annual fee exceeding 25%. Figure 1 shows the growth of overseas change buying and selling in India between 1999 and 2016. The inter-bank foreign exchange buying and selling quantity has endured to account for the dominant share (over 77%) of the whole buying and selling over this period, though there is an unmistakable downward fashion in that proportion. (Part of this dominance, though, effects from double-counting considering the fact that purchase and sales are introduced separately, and a single inter-bank transaction leads to a purchase as well as an income entry.) This is in keeping with world patterns. [Figure 1 about here] In March 2016, about 12 (48%) of the transactions were spot trades, while swap transactions (essentially repurchase agreements with a one-way transaction spot or forward blended with a longer-horizon ahead transaction in the reverse direction) accounted for 34% and forwards and ahead cancellations made up 11% and 7% respectively. About two-thirds of all transactions had the rupee on one side.

Trading is highly reasonably concentrated in India with eleven banks accounting for over 75% of the trades protected with the aid of the BIS 2004 survey. Features of the Forward premium on the Indian rupee 4 The Indian rupee has had an active ahead market for some time now. The forward top rate or cut price on the rupee (vis- -vis the US dollar, for instance) displays the market`s beliefs about future modifications in its value. The power of the relationship of this ahead top class with the activity rate differential between India and the US the Covered Interest Parity (CIP) circumstance gives us a measure of India`s integration with international markets.

The CIP is a no-arbitrage relationship that ensures that one can’t borrow in a country, convert to and lend in every other currency, insure the returns in the unique currency by means of promoting his anticipated proceeds in the forward market, and make profits except risk via this process. Chakrabarti (2016) reviews that between late 1997 and mid-2004, the common bargain on the rupee was about 4% per annum. During the duration, the common distinction between 90-180 day financial institution credit score prices in India and the inter-bank USD offer charge used to be about 4.5% for 3 months and 3.5% for the 6-months period. With these two figures in the equal ballpark (particularly given that financial institution savings quotes and inter-bank charges are now not strictly comparable), annual averages of hobby fee variations and the ahead exchange top rate additionally point out a moderate degree of co-movement between the two variables.

The activity price differential explains about 20% of the total version in the forward discount. The deviation of the Indian rupee-US dollar from the covered pastime parity, however, famous long-lived swings on each side of the zero line.

This would point out arbitrage possibilities and market imperfections furnished we may want to be certain of the comparability of the hobby charges considered. Therefore, while the behavior of the ahead premium on the Indian rupee is largely in strains with the CIP, extra cautious empirical evaluation involving without delay related pastime costs is essential to measure 5 the strength of the protected interest parity condition and the effectivity of the foreign exchange market. Under market efficiency, the forward alternate charge is considered to be an independent predictor of the future spot rate, with random prediction errors.

While the prediction errors of the ahead quote on the rupee show up to exhibit some diploma of persistence, any conclusion in this depends too have to look forward to greater rigorous analysis. Intervention in Foreign Exchange Markets The two important functions of the foreign trade market are to decide the charge of the distinctive currencies in terms of one some other and to transfer currency risk from greater risk-averse individuals to these extra inclined to undergo it. As in any market essentially the demand and provide for a specific currency at any particular point in time determines its fee (exchange rate) at that point.

However, the reason the fee of a country`s foreign money has an enormous bearing on its economy, overseas alternate markets regularly witness authorities’ intervention in one shape or another, to hold the cost of forex at or near its desired level. Interventions can range from quantitative restrictions on exchange and cross-border switch of capital to periodic trades by using the central bank of the u. s. a . or its allies and agents so as to move the alternate rate in the desired direction. In recent years India has witnessed both sorts of intervention although liberalization has implied a long-term policy push to limit and sooner or later cast off the former kind. It is safe to say that over the years for the reason that liberalization, India has allowed limited capital mobility and accompanied a managed float-type trade price policy. 6 During the early years of liberalization, the Rangarajan committee recommended that India`s change price be flexible.

Officially speaking, India moved from a fixed alternate price regime to a market-determined exchange fee device in 1993. The overt objective of India`s trade rate policy, in accordance with a number of policy pronouncements, has been to control volatility in change quotes barring focusing on any precise levels. This has been difficult to do in practice. The Indian rupee has had a remarkably stable relationship with the US dollar. Meanwhile, the dollar was preferred against primary currencies in the late 90s and then went into a prolonged decline especially all through 2003 and 2004.

The lock-step pattern of the US dollar and the Rupee is excellently reflected in the actions of the two currencies towards a 13 forex like the Euro. The correlation of the trade costs of the two currencies towards the Euro at some stage in 1999-2004 was 0.94. Several studies have mounted the pegged nature of the rupee in current years (see Chakrabarti (2016) for a more specific discussion).

Relation between Exchange Rate and Foreign Exchange Reserves

Abstract: Using time series data of the variables in the year 1980 – 2010 the present study tries to establish a causal relationship between exchange rate and foreign exchange reserves in the Indian context. Emphasis has been laid on understanding the impact of foreign exchange reserves on the exchange rate. India has accumulated unprecedented foreign exchange reserves and synchronously has been experiencing a large depreciation in its Rupee vies avis US dollar. This trend prompted us to undertake this study to establish some association between the two trends.

Introduction

Exchange rate fluctuation over a wide range bi-directionally (ceiling and floor) or in a unidirectional way tends to have a debilitating effect on the overall trade. Nations following the policy of import-linked export promotions will have a deep impact by currency depreciation on production costs thereby triggering inflation. The appreciation of currency creates a dampening environment for exporters. The exchange rate fluctuation can be intuitively governed by umpteen parameters which may include economic and non-economic factors like the capital inflows, interest rates prevailing in the economy, the rate of inflation, volume of foreign exchange reserves, current account balances, GDP growth rate, fiscal deficit, import to GDP ratios, export to GDP ratios, political stability, development indices, the corruption index, the health of the global economy, etc. The present study tries to understand the association between the foreign exchange reserves and the exchange rate in the Indian economy between 1980 and 2010. India has experienced an unprecedented increase in foreign exchange reserves (currency assets considered) which stands at 122.48 billion dollars in the year 2010-11 which is consistent with the Asian trend of accumulating excessive foreign exchange reserves. On the current account balance front India has always faced a current account balance deficit except between 2001 and 2003 when the current account balance was in surplus which was largely attributed to enhancement in the export of services. In the year 2010, the current account deficit stood at – 42.807 billion dollars. The exchange rate vies a US dollar is consistently in a depreciating mode.

What is the exchange rate?

An exchange rate is a rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.[1] For example, an interbank exchange rate of 114 Japanese yen to the United States dollar means that ¥114 will be exchanged for each US$1 or that US$1 will be exchanged for each ¥114. In this case, it is said that the price of a dollar in relation to yen is ¥114, or equivalently that the price of a yen in relation to dollars is $1/114.The government has the authority to change the exchange rate when needed.

Exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers, and where currency trading is continuous: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday. The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date

What are Foreign exchange reserves?

Foreign exchange reserves (also called forex reserves or FX reserves) are money or other assets held by a central bank or other monetary authority so that it can pay its liabilities, if needed, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institution. Reserves are held in one or more reserve currencies, mostly the United State Dollar and to a lesser extent the Euro.

India’s central bank which holds the foreign exchange reserve is RBI (Reserve bank of India) the currency is usually in form of “The US DOLLAR” because our dollar is dominating currency and is also used as the” primary currency for International trade”.

How central bank does have a large number of foreign reserves?

To know the working of foreign reserves we need to first know what is” foreign exchange market”

For example: imagine you are an exporter, you have certain goods which you export to the USA, and your trading partner will pay money to inform for dollars then you take the dollar which is usually a foreign currency. You deposit this currency into to commercial bank and exchange them into Indian currency to pay for your work as well as suppliers. So the commercial bank where you exchange the currencies will go to the foreign exchange market for the conversion

Foreign exchange market: A foreign exchange market is a market where the currencies of one country are traded to the currency of another country, but remember there is no physical marketplace where currencies are changing with other currencies. Because there is a huge network of commercial banks, investment banks, and Forex brokers which is spread across the globe and interconnected through telephones and computers.

For example: consider two countries India and USA and between there is a foreign exchange market both countries have commercial, investment banks, and forex brokers then there is the central bank in India which is RBI and in the USA there is a federal reserve. And now both countries have importers and exporters who do international business, then come individuals who are employees, students who are tourists, etc. Basically doing money transfers, currencies exchange while visiting foreign countries then comes large multinational cooperation which are engage in foreign economic activity so consider all these base level players who uses the commercial bank services investment banks and forex companies because they don’t have direct access to foreign exchange market so if you are individual who are employees, students who are tourist, importer and exporter you will be need the American dollar if you want to do business with the united states so in order to do that you need Indian currency per dollar then you will approach to the desk of commercial bank services investment banks and forex companies and then enquirer about the exchange rate now let’s assume that whatever the exchange rate was you had accepted it, then the dollars are immediately given to you now this financial entities haven’t open their short position they have to find a customer whose order will match this order to find the customer the foreign entity will approach foreign exchange market and the main goal of financial entity is to make profit

How is this central bank useful?

India has RBI as its central bank the role of RBI is to facilitate monetary policies otherwise these financial entities (commercial bank services investment banks and forex companies) keep looking for profits and will do so much currency conversion which may de-stabilized the economy now imagine if huge Indian currency is traded for a dollar and then all of the sudden the dollar value goes down just to keep a check on this the central bank comes into the picture

The functions of the central bank are:

• To control the money supply and exchange rate
• Control the release of national currency notes
• Control commercial banks lending and accept a limit
• Manages the country’s debt
• Maintain gold and foreign currency reserve
• Interacts with another central bank of the world

RBI collects some amount of foreign currency as a reserve and keeps them aside which may be useful in proper stock during a challenging time for example if there is a food shortage in the country should have enough reserves to pay for it which may last for 5-6 months regardless of all the country carries some amount of foreign exchange this reserve also include government securities, treasury bills, and government bonds.

Reserve accumulation can be an instrument to interfere with the exchange rate. From the first General agreement on tariff and trade (GATT) of 1948 to the foundation of the world trade organization (WTO) in 1995, the regulation of trade is a major concern for most countries throughout the world. Hence, commercial distortions such as subsidies and taxes are strongly discouraged. However, there is no global framework to regulate financial flows. As an example of the regional framework, members of the European Union are prohibited from introducing capital control, except in an extraordinary situation. The dynamics of china’s trade balance and reserve accumulation during the first decade of 2000 was one of the main reasons for the interest in this topic. Some economists are trying to explain this behavior. Usually, the explanation is based on a sophisticated variation of mercantilism, such as to protect the take-off in the tradable sector of an economy, by avoiding the real exchange rate appreciation that would naturally arise from this process. One attempt uses a standard model of open economy intertemporal consumption to show that it is possible to replicate a tariff on imports or a subsidy on exports by closing the current account and accumulating reserves. Another is more related to the economic growth literature. The argument is that the tradable sector of an economy is more capital intense than the non-tradable sector. The private sector invests too little in the capital since it fails to understand the social gains of a higher capital ratio given by externalities (like improvements in human capital, higher competition, technological spillovers, and increasing returns to scale). The government could improve the equilibrium by imposing subsidies and tariffs, but the hypothesis is that the government is unable to distinguish between good investment opportunities and rent-seeking schemes. Thus, reserve accumulation would correspond to a loan to foreigners to purchase a number of tradable goods from the economy. In this case, the real exchange rate would depreciate and the growth rate would increase. In some cases, this could improve welfare, since the higher growth rate would compensate for the loss of the tradable goods that could be consumed or invested. In this context, foreigners have the role to choose only the useful tradable goods sectors.

A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign exchange reserves. These reserve currencies usually become the international pricing mechanisms for commodities traded on the global market such as oil, natural gas, gold, and silver, causing other countries to hold this currency to pay for these goods. Currently, the U.S. dollar is the primary reserve currency in the world, kept not only by American banks but by other countries. Manipulating and adjusting the reserve levels can enable a central bank to prevent volatile fluctuations in currency by affecting the exchange rate and increasing the demand for and value of the country’s own currency.

Periodically, the board of governors of a central bank meets and decides on the reserve requirements as a part of monetary policy. The amount that a bank is required to hold in reserve fluctuates depending on the state of the economy and what the governing board determines as the optimal level.

Examples: In the past, reserve currencies have come about in a de facto manner: They simply were the currency that belonged to the most powerful nations or the ones that dominated trade. The Bretton Woods Agreement (see below) essentially appointed the U.S. dollar as the world’s leading currency reserve in 1944. But there are other popular currencies held in reserves.

The closest thing to an official list of reserve currencies comes from the International Monetary Fund (IMF), whose special drawing rights (SDR) basket determines currencies that countries can receive as part of IMF loans. The euro, introduced in 1999, is the second most commonly held reserve currency. Others in the basket include the Japanese yen and the British pound sterling. The latest addition, introduced in October 2016, is China’s yuan or renminbi.

System of Foreign Exchange in Malaysia

Introduction

This study is to inspect the effect of reserve assets ( gold, Bank Negara Malaysia external reserve, and foreign exchange), Malaysia’s lending rate, and the U.S. trade-weighted value of the U.S. dollar against major currencies on the exchange price movement in Malaysia. This part of the section will be discussing the background of the study, problem statement, research questions, research objectives, scope of the study, the significance of the study, limitations of the study, definition of terms, and also provide an overall summary of this part of the section. The content of the research or the report consists introduction, literature review, research methodology, findings and analysis, and also a conclusion and recommendation.

Foreign exchange is the system of converting and transferring one country’s currencies into another and vice versa. When it comes to the foreign exchange market, is a place where a trade or transaction were made and takes place day to day by buying and selling currencies. The market is open 24 hours a day and five days a week. Regarding market liquidity, the foreign exchange market is an active market where price quotes change constantly and resulting in high liquidity in exchanges. The currency exchange is conducted electronically via the over-the-counter (OTX), which in all transactions that are being traded will go through computer networks between traders across the gloves with no centralized exchange. The functions of the foreign exchange market also include the provision of hedging facilities, the provision of credit, and the transfer of purchasing power.

Furthermore, exchange rates will give a real impact on the return of an investor’s portfolio. Meaning that they will use technical and fundamental analysis in their trading strategies to determine the signals and the indicators. Fundamental analysis was brought to ббmean that foreign exchange traders will use economic data to gain ideas of the currency’s true value or intrinsic value whether it is undervalued or overvalued. But if we look into technical analysis, foreign exchange traders will use technical tools such as charts, trends, and indicators for their trading strategies and historical price actions in order to predict future price action and the signals to enter and exit the market.

Besides that, foreign exchange can be traded in three different ways which are in the spot market, forward market, and futures market. Spot market or in other terms, cash market which is a public financial market that is in its financial instrument or commodities are traded for immediate delivery. In a future market in which delivery is due at a later date but settlement is made on the contract date as compared to the spot market in which instruments are traded on an immediate basis. The future market is a customized contract and a forward market is a standardized contract. There are two ways to quote a currency pair either it is direct or indirect. When it comes to trading currency, there will be a bid price and an asking price for the currency. In which the bid price is the amount that the market will buy the quoted currency in relation to the base currency or the other currencies that will be traded. When it comes to the asking price, it is the amount that the market will sell which one unit of the base currency is in relation to the quoted currency. Usually, the bid price is always smaller than the asking price and cannot be another way around.

Background of the study

The competitive environment in today’s business world makes the search for attractive market opportunities more widespread than ever before. However, unexpectedly the number of US firms that even consider investigating, foreign markets is today, as in the past, low. The US Department of Commerce estimates that there are more than 18,000 US companies that have the potential to export, but do not (Woodward & Dickerson, 1986).

Malaysia was one of those Asian crisis countries that suffered from destabilization in the capital market due to insignificant foreign exchange trading in the late 1990s. The traditional measures that are taken up to stabilize the capital inflows during any financial crisis are raising interest rates and devaluation of the currencies. But this strategy did not work in the late 1990s in Malaysia and this led to thin foreign exchange trading in Malaysia. The volatility transmission and time-varying volatility are some of the factors that affect the foreign exchange market of Malaysia. The exchange rate of the Malaysian Ringgit is always changing following a slight change in the money value of the Ringgit and other currencies of the world.

For two decades, Malaysia, Indonesia, Thailand, and Singapore assign importance to exchange rate stability in their policy-making they are also the majority of the South East Asian country (Chong Lee & Tan Hui Boon). The foreign market has enrolled retail currency traders from all over the world because of its benefits. One of the benefits or one of the main factors of trading currencies is its massive trading volume, which covers the largest asset class in the world. This means that currency traders are provided with high liquidity. The foreign exchange market is open 24 Hours a Day, 5 Days a Week, if one major foreign exchange market close, another market in a different part of the world opens for business. While on the other hand, foreign exchange is not like the stock market, the foreign exchange market operates 24 hours daily except on weekends. Foreign exchange traders find this as one of the most compelling reasons to choose a foreign exchange since it provides convenient opportunities for those who are in school or work during regular work days and hours.

Bank Negara said there were encouraging signs of improvement in the balance of demand and supply of foreign currency that is more efficient in the foreign exchange market. In 2017 as reported in The Star online the improvement in liquidation in the foreign exchange market, the average US Dollar to MYR Ringgit bid-ask spread recorded a lower average of 24 points which related to a spreading of 46 points in 2016. Moreover, pricing in the onshore market is driven by real sector activities rather than speculative transactions which primarily comprised real sector trade flow which is more than 50 percent of the total volumes.

According to Bank Negara Malaysia money changing industry in Malaysia has grown significantly in the last decade. The industry had evolving over the years and it has developed gradually as reflected in the increased total turnover of exchange transactions. Bank Negara Malaysia recorded that as of the end of August 2011, the total turnover of the 4 industries stood at RM 17.7 billion which is an increase of 49 percent from 2005. In addition, there are over 800 licensees operating at more than 1,000 premises.

In fact, specific legislation to regulate the money-changing industry is the Money Changing Act 1998 which was enacted in March 1998. Based on the procedure, licensed money chargers must be provided by the retailer money changing services which Bank Negara Malaysia also regulates currency wholesalers. In addition, the main objective of regulation is to promote the protection of consumers through reliable, transparent, and professional conduct in the provision of money-changing services. Furthermore, to prevent the industry from being used as a conduit for money laundering and terrorist financing.

The money changing has initiated a review of the legal and regulatory framework by Bank Negara Malaysia in 2009 with the objective of modernizing the industry landscape and strengthening safeguards to protect the integrity of the industry. Moreover, it’s own a result that greater business flexibilities and opportunities including the ability to carry on multiple business activities within a single entity for qualified entities also promote greater synergies between the activities and economies of scale. Furthermore, the differentiation of regulations is required according to the nature, scale, and complexity of an entity’s business.

Problem Statement

According to (Ramasamy & Abar, 2015) influence the of exchange rate fluctuation is defined as the risk associated with unpredicted movements in the exchange rate. Macroeconomic variables such as interest rate, inflation rate, the balance of payments, tax rate, etc. The majority of the currency dropped against US Dollar in the global market. Therefore, investors were caught off by the near-complete absence of volatility in exchange rate movements.

The main problem in this research is about the volatility of exchange rate movements will impact the foreign exchange in Malaysia. In this study, the selected factors of exchange rate will be analyzed to provide a deeper understanding of the movement in Malaysia. However, there were still a few new currency investors who did not understand the basics behind currency movements. Investors or traders who are new to the currency markets need to understand the risks in order to be able to participate in the market. Only then can start trading currencies and apply many different strategies.

Factors affecting the exchange rate can be economic, political, psychological, and so on. Exchange rate behavior may be studied through macroeconomics variables or microeconomics variables. Policymakers would like to know what can be done to limit the fluctuation in the currency’s values and the forces behind it. There is still confusion in deciding the factors of the 5 exchange rate. Thus, to find the answers to these issues research is needed with the goal of explaining the exchange rate behavior.

Main Research Question

What are the factors that affect the movement of the exchange rate in Malaysia?

Specific Research Questions

• Does the variability of US-Trade weighted assets affect the exchange rate volatility in Malaysia?
• Does the variability of Malaysian reserve assets affect the exchange rate volatility in Malaysia?
• Does the variability of Malaysian lending interest rate affected the exchange rate volatility in Malaysia?

Research Objectives

The objective has been developed from the research problem and research question. The research objective also could be listed as fewer than two which are the main research objectives and specific research objectives.

1.5.1 Main Research Objective

The main objective is to determine the factors affecting movement in the exchange rate volatility of Malaysia which is MYR against USD. The United States is taken as the base country against Ringgit Malaysia.

Specific Research Objectives

• To investigate whether US trade-weighted asset affects the exchange rate volatility in Malaysia.
• To investigate whether Malaysian reserved assets affect the exchange rate volatility in Malaysia.
• To investigate whether the Malaysian lending interest rate affects the exchange rate volatility in Malaysia.

1.6 Scope of the Study

The variables that can give a big impact on the exchange rate of Malaysia ringgit to the US Dollar are the Malaysian lending interest rate, the US trade-weighted value of our dollar against major currencies, and Malaysian reserve assets as independent variables. The field of reference in this research paper is the period of twelve years. The data had been collected monthly starting from 2006 until 2018 got 144 samples of data had been used to regress. The study is conducted on the relationship between each of the independent variables towards the foreign exchange rate volatility.

1.7 Significance of the Study

The most rural issue that must be highlighted in this research paper is it must be related to the country’s policy, government, and foreign also national peoples. The intention of the investigation of this issue is to prove the volatility of foreign exchange rates whether can be affected by each of the independent variables. Moreover, there must be a limitation in seeking specific input about this issue one of which is the effectiveness of the exchange rate between one country to another country where the currency give a big influence on it. Then, after identifying the evidence of the issue there must be another variable that can be used as an independent variable which refers to macroeconomics such as lending interest rate and reserved assets. The final point of the issue is the US trade-weighted value of the US Dollar against major currencies where uncertainty results will occur because the US monopolizes the world economy.

1.8 Limitation of Study

In order to conduct good research and also this research needs to have an ongoing process including chapter 1, chapter 2, and so on, of course, there will be some limitations and barriers that will exist in order to complete this process and make a complete. Some limitations and barriers will be incurred in order to complete this research can be seen as follows:

1.8.1 Data Accuracy

To get good results in this research, the accuracy of the information or data is important. Not all the data available is free. It may need some payment for the information. It can be gathered from journals, annual reports, and the internet. Data and information are important keys when doing research. However, the data that is being gathered and collected may not be accurate with the scope of the study. This may due to a technical error during the data collection process.

1.8.2 Data constraint

Research can only be carried out if data is available. Using secondary data as the data collection method, the researcher has the limitation to search for the data. Some of the data can be found in the data stream and another potential source of data, but some of it cannot be found. The data can only be accessed in UiTM by using Reuters Thompson. When the researcher is able to search the data, another problem that occurs is the data is not sufficient for the number of observations.

1.9 Definition Key Terms

In this part, this research paper will explain all the dependent and independent variables that have been used.

1.9.1 Foreign Exchange Volatility

It is also known as currency volatility, this refers to the amount of uncertainty involved with the size changes in the currency. It is the unpredictable movement of exchange rates in the global foreign exchange market.

1.9.2 US-Trade Weighted Value of US Dollar against Major Currencies

The US-trade-weighted dollar is a measure of the US dollar’s foreign exchange value compared to certain foreign currencies. In comparing the value of the US dollar to all foreign 8 currencies, trade-weighted dollars give importance or weight to currencies most widely used in international trade.

1.9.3 Reserved Asset

A reserve asset is an asset that monetary authorities can easily use for a number of purposes. In order to reconsider a reserve asset, it must be an external physical asset, controlled in part by policymakers. The asset should be transferable easily.

1.9.4 Lending Interest rate

Interest rate is the amount charged by a lender to a borrower for the use of assets, expressed as a percentage of the principal. Interest rates are typically noted on an annual basis, known as the annual percentage rate (APR).

1.10 Summary

Foreign exchange is the most precious in the money market because it shows the volatility of each country. Variables such as Malaysian lending interest rate, US-Trade weighted, and Malaysian reserved assets are the determinants of the exchange rate in Malaysia. The researcher has highlighted how this variable would affect the volatility and thus it helped the researcher to have a clear understanding in depth of Foreign exchange towards the country. On the other hand, the researcher also came up with a problem statement on how the volatility of exchange rate movements will impact on the foreign exchange in Malaysia. The foreign market should provide many opportunities for investors. However, there were still a few new currency investors who did not understand the basics behind currency movements. Therefore, by using all the data and information provided this research paper will answer the objective and research questions of this study.

Story of Foreign Trade and Exchange

Free trade refers to the government’s abolition of trade barriers, tariffs, taxes, and quotas, as well as all other limitations on foreign trade that make it difficult to exchange such goods. Many countries consider free trade to be a noble concept because it removes obstacles, making exporting easier and less costly. Free trade along with product differentiation is very beneficial for a country and creates more winners than a loser in an economy.

Product differentiation is a marketing strategy for identifying product variations. Differentiation helps to increase the attractiveness of a commodity by comparing its distinctive characteristics with those of rivals. Product differentiation aims to gain a competitive advantage or to distinguish your product from competitors on the market. Product differentiation is very important in doing international trade as we should be able to provide something new than our competitors otherwise, it’s not very useful, for example, Japanese cars and US cars in the 80s were competing as Japanese car was more economical and that time there was the rise in fuel prices and US car ate a lot of fuel so, people were looking for something economical and, due to international trade they were able to get access to it and if the Japanese car was the same as the US than it wouldn’t be very viable for the customer to pay more and get the same product they already produce in their own country. Product differentiation provides a different option for the consumer in a country, it provides them with an alternative to choose from the same industry. It is from the point of view of demand-side this also benefits the supplier as they have a bigger market. There may be very minor variations between the goods, and the decision to purchase a foreign brand may not be based solely on price, but rather on other factors like product quality, performance, reliability, location, and services. (What is Product Differentiation? | Definition and Examples, 2021)

When we differentiate our product from the market it provides us with a competitive advantage talking about why there are more winners than losers when the country shift from no trade to free trade there is the various reason why there is likely more winners than a loser in a country. The trade barriers are also lifted so it is easier to trade with other countries. Consumers (buyers) and domestic businesses that export products are also winners of foreign trade (sellers). Consumers understand trade’s advantages in terms of choice and cost. Consumers benefit from international trade because they have access to a wider range of goods and services. Consider the products and brands we buy daily. If imports were restricted, our options would be extremely limited. For example, Nepal cannot manufacture cars, and if there was no free trade, people in Nepal would be unable to access them furthermore, by providing a wider range of options, the attractiveness of imported goods allows domestic producers to increase product quality while keeping prices down Trade benefits domestic vendors as well. The world, not only the domestic economy, is the market for domestic companies that export. Producing for a wider market allows them to expand and expand their production. They can take advantage of efficiencies and deliver goods at a lower average cost because of these economies of scale. Lower manufacturing costs help businesses compete more effectively, which can lead to lower prices for customers. And also international trade helps in the free movement of labor manufacturers can benefit from it they can get cheap labor which in turn will reduce the cost of production. Other benefits of free trade could be static gains as the differentiation increases the chances of export, stable employment, and higher wages, increase in factor of production, consumer saving, and catch-up benefits as developing countries could take advantage of it.

The advantages of trade are not limited to the immediate producers and consumers. Economic growth and an increasing standard of living support countries that participate in foreign trade. This can happen in two ways. To begin with, trade provides countries with physical resources (technology, machinery, and equipment) that they would not be able to manufacture on their own. China, for example, has developed into a manufacturing powerhouse and India has become a pioneer in service exports. Both countries have seen growth and development that would not have occurred if they had not had access to foreign markets. Economists believe that trade offers the poorest countries a way out of poverty. Foreign trade means exchanging goods and services the other party finds beneficial. Third parties, on the other hand, must be recognized that certain people are worse off as a result of foreign trade. Companies that offer goods that can’t compete in a global marketplace are the most visible third-party losers. So to be able to survive when a country goes from no trade to free trade product differentiation is important. So that in the long run economies don’t suffer.

We can support this with different theories like Intra industry trade theory. This theory says that two countries with similar resources will still trade goods of the same industry with each other because they have similar resources which is a different concept from other trade theories which focus on selling goods that they specialize in or have a comparative advantage. Other theories like an absolute advantage, comparative advantage theory, and the HO model can explain the trade pattern between countries which have different resources but, our main focus with this statement is product differentiation as a basis for international trade and how there are more winners than losers when a country converts from no trade to free trade. Standard trade theory assumes trade in similar goods; hence, with perfect competition, only inter-industry trade occurs. When two countries trade developed and developing other theories like absolute advantage theory can be related as a basis that they both have different resources if a country specializes in labor abundant product then they should produce only that kind of product and if a country specializes in the capital intensive product they should produce only that kind of product. This theory tells us how trade occurs in homogeneous products.

Another standard trade theory of comparative advantage propounded by David Ricardo says that nation will gain from trade even if it has no absolute advantage in making any product. He also emphasized a major aspect of the theory: products are more mobile across foreign borders than resources (land, labor, and capital). The theory of intra-industry trade is still based on this premise. This theory of trade is intended to demonstrate that any nation can efficiently exploit any differences between countries. Whether a country has increased wages or lower productivity, the competitive wage rates in place ensure that each country focuses on the product in which it has a competitive advantage.

These standard trade theories are only relatable to some extent as they only take homogeneous goods as the main trade statement talks about product differentiation but in the case of these, they mostly deal with homogenous goods in a perfect market.

The previous explanation of the underlying causes of inter-industry trade focuses on country differences. However, a lot of foreign trade can happen between similar countries. This is where the Intra-industry concept is important. Trade does not have to be the consequence of differences in technology between countries or factor proportions between countries; it can simply be a means of expanding the market and fully exploiting scale economies. Intra-industry trade occurs when countries sell products with virtually equal factor intensities and is often between countries with similar factor endowments. Intra-industry trade happens whenever countries trade goods that are essentially the same. Let’s take an example of a watch to assume that it is differentiated which means there will be specialization within the watch group, with one country making more athletic watches and the other manufacturing more expensive watches. Larger markets have more opportunities to produce a greater variety of products from the same industry. The market is monopolistic in It benefits both consumers and sellers. In this type of market, many sellers are competing against each other but the product they sell is differentiated. Firms in a monopolistically competitive market distinguish their goods to ensure that they are imperfect replacements for one another. As a result, a company that strengthens its branding will boost prices without jeopardizing its customer base. Suppliers have more command in the market, unlike a perfect competition market. Product differentiation is critical since it enables different brands or businesses to achieve a competitive advantage in the marketplace. If the distinction were impossible, the market would still be dominated by larger companies with economies of scale because they can beat small companies on price. In this intra-industry trade growing more countries are getting into intra-industry trade one of the main reason for growing intra-industry trade is product differentiation.

In conclusion, we can say that product differentiation is the basis of international trade. Countries that have dabbled in free trade have been invited to join more FTAs or organizations, including the most populated, oldest, smallest, and weakest economies. This is because they claim that lowering trade barriers and increasing product differentiation would help them expand trade with other countries. Though some people might think that International trade benefits those with advanced technologies and the opportunity to manufacture high-quality, low-cost goods; free trade, in particular, has significant implications for those employed in import-competing sectors this means they will lose market for their product. That’s also mainly because of a lack of awareness of the strengths of free trade and product differentiation; but, once they realize that most of the international trade is based on product differentiation, the countries would have more winners than losers as a result of free trade benefits. There would be no foreign trade if there was no product differentiation and everyone would be pleased with what they make. People buy from other countries only if there is a differentiation between what they get in their own country whether it be price, quality, or service. Like people in china will not spend on buying iPhones if the features and design were not different from Huawei’s products. (Impact of the Product Differentiation on Free Trade